“Indemnity” is a legal term that often arises in discussions and dealings with business contracts. The term means that if one party to a contract suffers a loss because of a second party’s conduct, the second party has to compensate the first party. Please note, though, that the specific scope and effect of an indemnity clause will likely depend on the intent of the parties and the way in which the clause was drafted.
What is the Meaning of “Indemnity”?
The term essentially refers to Party A’s promise to pay Party B for the losses he/she suffers because of some triggering event caused by Party B. This so-called “triggering event” is typically defined by the parties to a contract and it could include things like Party A’s:
- breach of contract,
- infringement
- specific acts or omissions, and/or
- negligence or fault.
How Does it Impact My Business?
An indemnity provision essentially protects one contractual party from financial loss. This means an indemnity provision helps you alleviate some of the risks associated with an agreement. They also help you avoid liability for another party’s acts.
Consider, for example, a software developer your company hire’s to build software for your new product built the software using the intellectual property of a third party without their permission. You launch the software and then face a lawsuit from the original owner of the software. In this situation, you would seek indemnity form the developer for the damages including legal fees you incur as a result of the infringing software.
Please note, though, that even with an indemnity provision, you will bear sole liability for:
- any losses caused by your deliberate acts, and/or
- any losses caused by your own fraud or illegal acts.
When do I Need an Indemnity Provision?
The answer really depends on the facts surrounding an agreement and your bargaining position in relation to the other party to the contract. If a contract involves a high-risk event or arrangement, you will want to try and ask for an indemnity provision from the other party. Further, if you are in a stronger bargaining or negotiating position than another party, you might want to ask for an indemnity to help minimize any possible risk of loss.
The following are examples of agreements where parties typically try to include an indemnity provision:
- Software licensing agreements,
- Share purchase agreements, and
- Contracts that assign intellectual property rights.
Are There Key Considerations in Drafting an Indemnity Clause?
Yes. If you would like to include an indemnity clause in a contract, please consider the following:
- What specific loss could incur (for example, is it a specific amount of money, the loss of reputation, etc.),
- How could the loss take place (here, ask what specific triggering event could spark a loss), and
- Who is the best party to bear responsibility for the loss.
In terms of the last consideration, this is the party that you would ideally like to have sign an indemnity agreement.
Please also note that the parties to an agreement can negotiate how much of a loss that one party should bear. For example, the parties could agree that one party should incur all of the losses associated with a triggering event, or perhaps that the party only cover a list of specific losses.
More questions? Not sure if your agreements need an indemnity clause?
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